Whatever You Do, Don’t Read This Column

In one recent survey, wealthy individuals said they expect their portfolios to earn a long-run average of 8.5% annually after inflation. With bonds yielding roughly 2.5%, a typical stock-and-bond portfolio would need stocks to grow at 12.5% annually in order to hit that overall 8.5% target. Net of fees and inflation, that would require approximately doubling the 7% annual gain stocks have produced over the long term.

Individuals aren’t the only investors who believe in the improbable. One in six institutional investors, in another survey, projected gains of more than 20% annually on their investments in venture capital — even though such funds, on average, have underperformed the stock marketfor much of the 2000s.

Although almost nothing is impossible in the financial markets, these expectations are so far-fetched they border on fantasy.

The traditional explanations for believing in an investing tooth fairy who will leave money under your pillow are optimism and overconfidence: Hope springs eternal, and each of us thinks we’re better than the other investors out there.

There’s another reason so many investors believe in magic: We can’t handle the truth.

The efficient market hypothesis holds that stock prices fully reflect all the relevant information that is available. What if, instead, investors are so efficient at avoiding some information that it might as well not even exist?

Psychologists call this behavior “information avoidance.” You could also call it intentional ignorance.

“It’s a motivated decision to say ‘no’ to learning available but unwanted information,” says Jennifer Howell, a psychologist at Ohio University in Athens, Ohio, who studies the phenomenon. “People avoid information if it’s going to make them feel or behave or think in a way they don’t want to” — especially any evidence that could jeopardize their belief in their competence and autonomy or could require taking difficult or prolonged action.

After all, information isn’t just bits of data or trivia. It can also be the cause of pleasure or pain. If the information is pleasant, that positive feeling gives you more incentive to pay attention to it. Painful information can push you to ignore it.

Think of people declining to get tested for the genetic markers of a hereditary disease, or a smoker whose cigarette packs might as well have that warning from the Surgeon General printed in invisible ink.

Investors often act much the same way.

The behavioral economist George Loewenstein and his research colleagues have shown, using data from Vanguard Group, that investors check the value of their financial assets much less frequently, on average, in down markets — a behavior the researchers call “the ostrich effect.”

Such behavior isn’t always bad. Covering your eyes and ears during a market downturn can keep you from kicking yourself with regret — and from bailing out near the bottom.

However, you can’t tell whether your ideas are valid unless you let them be challenged. Just as the most partisan voters — of all stripes — shouldn’t remain deaf and blind to evidence that their favorite politicians might be wrong, investors would spare themselves embarrassment and loss by confronting information instead of hiding from it.

So, when you or your financial adviser estimate future performance, ask: What are the sources of this expected return (income, inflation, capital appreciation and so on)? How much of the total will come from each? How do those expectations compare to the long-term past results and, if they differ, by how much and why?

While that isn’t impossible, anyone calling for even higher returns after years of robust gains in stock markets around the world needs to look for loopholes in his or her logic.

Finally ask: What conditions or circumstances would it take for me to be proven wrong? If your answer is “none” or “that’s impossible,” you have a severe case of information avoidance. The only cure for that might be the shock of losses that come at you like a bolt from the blue.